Setting up a business abroad in the right way can save you significant money, among other benefits. However, we often see entrepreneurs making the same costly mistakes when going offshore.
Here we share a list of seven common mistakes, so you know what to watch out for.
1. Choosing the wrong jurisdiction
You may have seen articles or forum discussions on “the best offshore jurisdiction”. But unfortunately there is no one-size-fits-all answer. Which jurisdiction is the best for you depends on your business and your objectives for offshoring.
Read our Whitepaper on choosing the best jurisdiction.
2. Not setting up the right business structure
Many entrepreneurs and investors start out without a formal legal structure, or outgrow their initial structure. However, almost every investor and entrepreneur can realize tax savings, legal protections and other benefits by operating with the right business structure. Whether you are seeking outside investment, if your investors/owners are US persons or not, and what the ownership structure is, it will all factor into the optimal business structure to use.
3. Overlooking transfer pricing
Understanding transfer pricing is important when there is a relationship between a US based company and a foreign company owned by the same person. In this case, a transfer pricing study must be performed in order to document this relationship and to ensure that an arm’s length transaction/price is given, meaning that goods or services are exchanged between the two companies at fair market value. This is an audit red flag as the IRS is aware of people setting up this type of relationship to shift profits from the US to a lower tax jurisdiction.
4. Being unaware of reporting requirements
There are many reporting requirement in regards to disclosing foreign companies (form 5471), bank accounts (FBAR/8938) and overseas transfers (form 926) which are important to file correctly. There are other cases where a form 8858 for disregarded entity or form 8865 for foreign partnership might be applicable as well. Make sure you know the IRS classification of your entity and are filing correctly as failure to do so can result in $10,000 fines. In addition there may be reporting requirements in your offshore jurisdiction.
5. Not keeping expense records for US tax reporting
The US IRS has the right to audit ANY business owned by a US person, foreign and domestic. Therefore you must report expenses and maintain records, just like you would for a US business. Please keep receipts and maintain good books for your foreign company. If you have wrong information on form 5471 you are still subject to the $10,000 fine, even if you file timely.
6. Overlooking implications of foreign partners
To be a CFC or not to be a CFC, that is the question. If the entity is owned by over 50% US shareholders and under 11 shareholders in total, the foreign company is considered a Controlled Foreign Corporation (CFC). This changes both reporting and tax implications for the company and transactions with related parties. If possible, keep US ownership under 50% to make your life easier. Also watch out for constructive ownership rules about how foreign relatives count towards your ownership percentage.
7. Inadvertently becoming a PFIC
If you own a foreign company that holds passive investments, whether stocks, bonds or real estate, it can be considered a Passive Foreign Investment Company (PFIC). This will have negative consequences for you when you sell the company. There are several ways to avoid PFIC treatment such as the check the box election.
How to avoid these mistakes of businesses abroad
Being aware of the common pitfalls is the first step. You can steer clear of many issues through careful planning. Working with a structuring expert will help you to select the right structure and put the best plan in place to avoid these common mistakes when setting up a business abroad.
If you’d like to learn more, please schedule a consultation.
Image by Ingo Joseph
